A current look at China’s financial futures industry

In the past we haven’t spent too much time looking at the development of China’s financial futures market, but if you were to ask any China capital markets observer what some of the most important reforms of the past few years included, the introduction of the financial futures market would be one of them.

Before we get into the details though, it is worth quickly reviewing what financial futures are and their primary uses.

Financial futures can be divided into mainly five categories: interest rate futures, currency futures, stock index futures, FX futures and government bond futures. So in general, the underlying of any financial futures are other financial instruments with the primary usage being to hedge the risks of price fluctuation in the underlying assets. In addition, many investors use futures to speculate on market movements – a practice supported by the availability of margin trading.

In the west, financial futures have developed for decades and the market is becoming more mature, but here in China, financial futures is relatively new product and currently there is only one stock index future called CSI 300 index futures operating under supervision and on the platform of CFFE (China Financial Futures Exchange).

So in order to catch up with the western mature financial futures market, the CFFE officials are studying and testing the government bond futures, foreign exchange options and index options. Government bond futures are likely the next type to be released in 2012, probably in November which will be something that financial institutions and investors will be keeping an eye on.

As the Chinese stock market does not have convenient way of short selling except financing securities through certain securities company with very strict threshold, the index futures market is a new place for short sellers to do short selling because the index futures can influence the stock market seriously. As future markets are traded using the leverage mechanisms and the t+0 trading regulation, the fluctuations can be much larger than their underlying assets. There will be emerging opportunities for professional speculators and high-frequency trading software to be used.

So how do we estimate what will happen and what will be improved by Chinese financial futures market? The answer is that we should compare the mature markets with Chinese market to see what the gap between them and normally Chinese financial futures market will learn from the western ones; so we can surely expect the emergence of new categories of financial futures. The Chinese government and futures markets wanted to accelerate the process of issuing new future types including commodity futures. It was reported that about 10 new categories of futures are under testing and will be released in the future.

Apart from adding new products, the CSRC and CFFE have recognized that the risk control systems in place are not very mature and the two organizations are working to improve on them. Price limit, circuit breaker and speed bumps are the universal 3 automatic stability mechanisms in futures risk management systems and the market is working to introduce these mechanisms. The structure of investors in Chinese market is also different from the more mature markets as the individual retail investors represent a larger proportion of volume in the CSI 300 index futures market - the proportion of institutional investors is still small compared to that in the western countries and it is highly likely that QFII will be allowed to enter Chinese futures market in the near future. So many opportunities for financial IT companies will emerge because of the expected more investment institutions entering the Chinese financial futures market. New programmed trading software will likely need to be developed.

China’s financial futures market is in its infancy, but volume and uptake shows that it is a market that is in demand and will likely stay that way into the future. Expect to see more changes in the next year.